Kathy Ellis is the engagement partner for the audit of Spunky Securities, an investment firm. Most of Spunky's assets and liabilities are financial and their valuation is critical to the assessment of the company's solvency and profitability. Kathy has employed two outside experts to value the financial assets and liabilities because they are extremely complex to value, particularly the energy market derivatives and the instruments traded in foreign markets. In addition, the valuations are highly dependent on market conditions and the specific and detailed requirements of the recently revised accounting standards.

Throughout the current year's audit, Kathy has had difficulties with the CEO of Spunky Securities. He is vehemently opposed to any asset write-downs she has recommended. The CEO has the backing of the chairman of the board, and Kathy has ben unable to get the CEO to agree with her concerns about the valuations of the financial assets and liabilities the company has made. In past year, Kathy has had an amicable relationship with both the CEO and the chairman, and the audits have run very smoothly. Kathy now realizes that this harmonious relationship was mainly due to the boom in the market. It was unlikely there would be arguments about writing up the value of the assets during these good times.

Kathy, with the help of the experts, has prepared a summary of the relevant items, detailing the revised values for the assets and liabilities and the associated effects on income and retained earnings. The CEO has dismissed this summary and the audit recommendations with the comment, "The market has hit the bottom and is recovering. There is no need to show these write-downs because by the time the financial statements are published, the values will be back to where they were before the market fell. It is all a waste of time. In fact, I think you are just being difficult. I think we need an auditor who is a bit more realistic."

Please respond to the following:

a) Kathy has planned a meeting with the Board's audit committee. Draft a brief report (one full paragraph or so) that she will share with the committee to frame the discussion. Write this in a professional manner, given the context of an audit partner writing to the audit committee.

b) Kathy is also drafting the management representation letter that the CEO will need to sign. If he refuses to sign the letter, state the implications for the audit.